National Institute of Economic and Social Research

Thursday, 5 July 2012

Full circle on policy? Let's hope so.

The
G-20 has come full circle.In April 2009
in London the talk was of a massive coordinated fiscal stimulus. While this was
considerably exaggerated - much of the "trillion dollar package" has
already been announced - there was a genuine collective determination to do
what was necessary to ensure the financial crisis did not become a prolonged
depression.

And
it worked, perhaps too well. By June 2010, in Toronto, it appeared that
recovery was underway. The new priority,
in what the UK government described as
a diplomatic triumph, was fiscal consolidation: the Summit
Communique noted approvingly that "advanced
economies have committed to fiscal plans that will at least halve deficits by
2013 and stabilize or reduce government debt-to-GDP ratios by 2016."

It is now clear this premature "pivot" to fiscal
consolidation, as the IMF described it, was a huge mistake, both for the G20 as
a whole and for the UK. The supposed commitment
to halve the deficit by 2013 has been quietly forgotten, derailed by weak growth.
At this week's G20 in Los Cabos, the target will, rightly, be growth
and confidence, not self-defeating austerity; although it is
far from clear that this will translate into meaningful policy.

What
does that mean for the UK? Politicians, perhaps even more than the rest of us,
like the idea of getting something for nothing. But the Chancellor's Mansion
House speech was unusually frank in this respect. On the one hand,
"the costs and risks of discretionary fiscal loosening..are real and
significant". So no more borrowing.
But on the other hand: "we can use the global confidence in our balance
sheet to boost private sector growth. We are already taking action to
support new house-building and infrastructure investment through government
guarantees. In the next month we will set out how we can do much
more." So much more borrowing, underwritten by taxpayers. Let's borrow more without borrowing more;
more debt is now a good thing, as long as it doesn't count.

The
most important point about the speech is that it marks the end of the economic
argument about the need for more government borrowing and spending to support
demand. No doubt the Treasury will find
a way of ensuring that whatever guarantees are offered have no direct,
short-term impact on the deficit, in Treasury accounting terms. But economically that's irrelevant; there is
only a marginal difference between the government borrowing directly from the
private sector to finance investment spending, and the government guaranteeing private
sector borrowing that finances the same spending.

Of
course, taking the financing off balance sheet just for presentational reasons
is non-transparent and potentially costly, as Martin Wolf points
out. The most direct and
efficient way to increase spending on infrastructure would be for the
government to borrow directly. Indeed, with long-term government borrowing is
as cheap as living memory, this is the obvious and economically rational way to
go. Long-term real interest rates are
very close to zero - as I pointed out recently, we could finance a £30
billion infrastructure investment plan with the revenues raised from the
now-cancelled pasty tax.

But,
even within the government's self-imposed restriction to off-balance sheet financing,
there are some sensible things that could be done

as Tim Leunig and Tim Besley have proposed, the government could kick-start
housebuilding by guaranteeing bonds issued by housing associations, secured on
the income stream from new houses, and coupled with an innovative approach to
ensuring a supply of appropriate land with planning permission. With housebuilding, especially of affordable
homes, at historic lows, while the UK still suffers from a structural shortage
of housing supply, this would both boost demand in the short term and benefit
the economy over the medium to longer term.

as the ACEVO Commission on Youth Unemployment, of which I was
a member, argued, the long-term economic and social damage that will result
from current levels of youth unemployment is immense. The government could
enable private and voluntary sector providers to invest now in reducing youth
unemployment, by promising a substantial future payment stream in return for
demonstrated success. This could in turn
enable providers to issue social impact bonds secured on those future payments.

the market for loans to small and medium enterprises is
dsyfunctional; this both reduces business investment and hence output and
employment in the short term, and holds back productivity in the longer term.
As Adam Posen at the Bank of England has suggested, the
government could unblock the market and increase financing to the SME sector by
creating a securitisation vehicle for SME loans. Such securities could then be
purchased the Bank of England as part of its quantitative easing programme,
again underwritten ultimately by the Treasury.

All
of these measures would boost demand, investment and employment. All would of
course entail the government assuming some risk. And all would, in economic
terms, constitute a "fiscal stimulus".But none would add significantly to the measured
deficit in the short term.The priority
now is for the government to turn words into action.

4 comments:

I’m not sure about the idea that government should borrow and invest in infrastructure NOW because of low interest rates. First, those low rates are to some extent artificial: they result partially from the fact that the government / central bank machine has manipulating interest rates downwards so as to deal with the recession.

Second, it has long been accepted that government funded infrastructure projects should be debited with some sort of COMMERCIAL rate of interest, not the rate at which government can borrow. This is because governments have an unfair advantage when it comes to borrowing: they can extort money from the population (via tax) to pay interest and repay capital.

In fact I’d go further, and suggest that, contrary to the conventional wisdom, there is no big merit in funding infrastructure from borrowing rather than from tax. Kersten Kellerman argued this point in a paper in the European Journal of Political Economy. Paper title: “Debt financing of public investment: On a popular misinterpretation of “the golden rule of public sector borrowing”.

Also Milton Friedman advocated a “zero government borrowing” regime. See p.250 here:

Whether the rates are low naturally or artificially, those are the rates that the government pays. If we accounted the rate of government borrowing at any rate other than the rate that the government paid to borrow, then government accounts would not line up.

In other words, the government is definitely getting a great deal. You're suggesting that the government shouldn't take the deal because it isn't fair. But nonetheless, they're getting a great deal. If they borrowed to finance infrastructure, or even accelerate already scheduled payments, the tax payer could be getting a great deal too.

(I'd also add that fairness is a concept that has little relevance to economic questions. If we were concerned with fairness more than efficiency we'd have to throw the whole system out anyway.)

Economics is all about how to most efficiently allocate REAL RESOURCES. Your first paragraph seems to be saying that making government book-keeping entries look tidy is more important than efficiently allocating resources. I find that a very strange argument.

Re your second paragraph, I fully agree that “government is getting a great deal”. The “greatness” of the deal derives, as I pointed out in my earlier comment, from government’s coercive powers: the power to extort money by force from citizens and/or the power to impose artificial rates of interest. By the same token, the Mafia can doubtless get some “great deals” for itself by engaging in extortion and/or imposing artificial prices for various goods. I don’t think that means that the various “deals” done by Mafia make economic sense.